JUDGMENT R.M. Sahai, J.
1. In this reference, at the instance of the assessee, a private limited company, what survives for consideration is whether the commission paid by the assessee to its directors having been found to have been for commercial expediency could be curtailed by the Tribunal as excessive or unreasonable because it resulted in the diversion of the major profit to the directors.
2. Although, on facts found, the application under Section 256(1) of the assessee for referring the question of law arising out of the order passed by the Tribunal was rejected, it was allowed by this court under Section 256(2). Consequently, the Income-tax Appellate Tribunal, Allahabad Bench, Allahabad, referred the following question of law :
"Whether, on the facts and in the circumstances of the case, the Tribunal was justified in disallowing part of the commission paid to the directors of the assessee-company for the assessment year 1975-76 ?"
3. In the return filed for the assessment year 1975-76, the assessee, carrying on business of export of carpets, claimed deduction of Rs. 86/158 paid by it to four of its directors for whole-time work and promotion of export. It was disallowed by the ITO as it was "not for business purposes but other considerations". The Commissioner (Appeals) also did not find any merit in the claim of the assessee as payment of Rs. 86,158 to the directors as against profit of Rs. 21,680 to the company could not be considered reasonable. The appellate authority found :
"The commission has to be related to some specific service rendered and it can never be assumed that all the four working directors irrespective of their difference of age, skill, experience and technical knowledge would be rendering services from which the company would derive equal benefit so that it could be said that the payment was for the legitimate business needs. The clear intention by providing an increasing scale of commission to be paid to the present and future directors on the export figures is for reducing the profit of the company so that legitimate tax burden is reduced, the natural presumption being that the more the exports the more will be the company's pro6t."
4. In further appeal, although the Tribunal found that for determining the reasonableness of the payments made to the directors, the profit criterion should not be made the main basis, yet it held that it is reasonable to allow a commission payment of 1% only. Payment of commission, therefore, was for commercial expediency. Narrow field left for determination is if there was any material after delinking it with profit to hold that it was excessive. ITO and Commissioner (Appeals) laboured under a misapprehension that the assessee took over the business of M/s. Kashi Prasad and Sons. In fact the assessee-company was incorporated on July 3, 1971, when the firm, M/s. Kashi Prasad and Sons, was continuing and doing business of carpets and exports and was dissolved on November 3, 1971, only. The Tribunal found that two of the directors joined in October, 1971. Prior to this, they were working in their individual capacity and also as karta of their respective HUF. For this they were paid approximately Rs. 2,500 and Rs. 3,000 p.m. When they joined the company it was understood that they shall function as whole-time directors and shall not undertake in future any new business in the same line. But they were not paid any commission or remuneration in the first year of business despite a letter sent by the directors in November, 1971, as the company was still in its infancy. Reminder was sent by the directors in June, 1972, claiming that as the firm was now established due to their untiring efforts and unreserved devotion, they be paid Rs. 3,000 as salary and commission graded with export beginning from 1% up to Rs. 20,00,000 and 2 1/2% beyond 50,00,000. Although it was taken up in a meeting of the board of directors, its consideration was deferred to the extraordinary general meeting by the general body in August, 1972, when payment of salary of Rs. 1,000 from September, 1972, was resolved but question of commission was deferred. It appears to have been allowed in 1974, for the first time to be effective from 1975, that is, 1975-76. Commission was to be paid in proportion to export promotion beginning from 1% up to 20 lakhs, then raising it up to 2 1/2%. Under it, 2% was payable if export was between Rs. 30 to 50 lakhs. In the years in dispute, it was Rs. 43,15,016. Salary and bonus to directors came to Rs. 40,000 and commission paid to directors was Rs. 86,186. Net income to company was Rs. 21,680. It was found that it was 20% of the salary, bonus and commission. But the Tribunal held that in the next year the profits of the company multiplied by five times and in the third year by ten times, therefore, ratio between the net profit of the company and the payments made to the directors was reduced to 3/5ths and 2/5ths. Further, the Tribunal found that the assessee had not claimed any salary for its executives and if what was paid to them before they joined the company is taken into consideration, then, even after four years of untiring labour, they were getting nearly the same. But the Tribunal, despite recording all this finding, could not shake off the fueling that the major chunk of profits was taken away by the directors.
5. In doing so, it omitted to consider that excessiveness or unreasonableness under Section 36(1)(ii) or Section 40(c) have to be considered from the standpoint of a prudent businessman. The company was incorporated in 1971. Since then its directors were claiming salary and commission. Nothing was paid in the first year. Token salary was paid in the second year. It was only in the third year that commission was paid. In the year in dispute it was no doubt 20%, but the experience of the directors, their past remuneration, whole-time work, etc., could not be ignored. Excessiveness or unreasonableness contemplated in these sections could not be left to the subjective opinion of the I.T. authorities. The opinion as to the reasonableness or otherwise of the amount spent must be formed having regard to the legitimate business needs of the company and the benefit derived by the company or accruing to the company from the said sum expended : CIT v. Edward Keventer (P.) Ltd. [1972] 86 ITR 370 (Cal). The Supreme Court, while affirming the decision in Keventer's case [1978] 115 ITR 149, found payment of Rs. 4,500 per month to directors, that is, nearly Rs. 54,000 per year to directors as remuneration and commission against annual turnover of Rs. 23,66,000 to Rs. 30,86,000, was neither excessive nor unreasonable. It also found that total expenditure on staff was Rs. 500 per month only. Applying the above test, it cannot be said that the payment to the directors was excessive.
6. For reasons stated above, we answer the question referred to us in the negative, in favour of the assessee and against the Department by saying that the Tribunal was not justified in disallowing part of the commission paid to the directors of the assessee-company for 1975-76. Assessee shall be entitled to costs which are assessed at Rs. 200.